The economy is somewhere down there.

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This Recovery Really Is Different

Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”
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Calling this the “worst economic expansion since World War II” is like saying the ebola virus is the worst cold you ever had. At some level you might be technically correct, but you end up communicating confusing, even misleading, information.

This keeps coming up, despite a wealth of evidence that provides more appropriate context about the crash and subsequent recovery. A column in Real Time Economics is typical of the genre:

Since the recession ended in June 2009, the economy has advanced at a 2.2% annual pace through the end of last year. That’s more than a half-percentage point worse than the next-weakest expansion of the past 70 years, the one from 2001 through 2007. While there have been highs and lows in individual quarters, overall the economy has failed to break out of its roughly 2% pattern for six years.

The key that something is wrong is in the outlier status of the data. “More than a half-percentage point worse than the next-weakest expansion” is an enormous, Bob Beamon-like smashing of the earlier record. To better understand this data requires some context, which today’s column will provide.

First, the specifics: By just about every economic metric, this has been a mediocre, subpar recovery. For the first few years following the end of the recession in June 2009, employment increased slowly. Wages to this day have been little changed. Retail sales have been inconsistent; housing has seen soft sales numbers, while price increases have been a function of a lack of inventory caused by limited amounts of home equity and immobility as a consumer try to reduce debt. Gross domestic product growth has been weak and lacking in consistency.

The context is simple: When we discuss expansions, we typically are referring to the later half of a typical economic contraction-expansion cycle. That is what is typically referred to as a post-recession recovery.

However, that huge outlier is a clue that we are using the wrong data set. The post-World War II recession recoveries are the wrong frame of reference; the proper one is the much more severe set of credit-crisis collapses and recoveries.

Economists Carmen M. Reinhart and Kenneth S. Rogoff figured this out before the scale of the crisis even was apparent. In January 2008 they published a paper titled "Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison." They warned that the U.S. subprime mortgage issue was turning into a full-blown credit crisis, not just a typical recession. I discussed this extensively in February 2008

The economic researchers were astute enough to not use other recession-recovery cycles as their comparison when discussing the pace of growth in the U.S. economy after what they said would be a collapse caused by subprime mortgages. Instead, they suggested looking at five previous financial crises -- Japan (1992), Finland (1991), Sweden (1991), Norway (1987) and Spain (1977).

These earlier financial and credit crises had several consistent elements: A prolonged and deep decline in asset prices, including equity (average of 55 percent) and housing prices (average of 35 percent). They also noted that banking crises are followed by “profound declines in employment.” The average increase in the unemployment rate was seven percentage points during the four years after the collapse. This is in line with the rise in the U.S. unemployment, rate, which increased from about 4 percent to 10 percent.

Other elements they saw as consistent with credit crises were an explosion of government debt, and costly “ambitious countercyclical fiscal policies aimed at mitigating the downturn.”

Let me remind you that Reinhart and Rogoff published their paper in early 2008 --before Bear Stearns collapsed, and well before Lehman Brothers, American International Group, the banks and government-sponsored entities Fannie Mae and Freddie Mac either failed or needed bailouts. I give them enormous credit for not only understanding how subprime mortgages were a threat to the economy, but seeing exactly how that threat would manifest itself, and how the subsequent recovery would take form. 

The key point here is that credit bubbles are very different from ordinary recession recoveries. Bank crises and the long, slow painful recoveries are simply not comparable to other business cycles.

After the collapse, Reinhart and Rogoff turned their research into a book, “This Time Is Different: Eight Centuries of Financial Folly.” Anyone who wants to understand the present economic cycle should give it a read.

So next time someone says this is the worst recovery since World War II, remind them that the economy is recovering from a full-blown financial crisis -- not just a typical recession.  

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Barry L Ritholtz at britholtz3@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net